(II) THE MUNDELL-FLEMING MODEL

Transcription

1 (II) THE MUNDELL-FLEMING MODEL LECTURE 3: THE MODEL WITH A FIXED EXCHANGE RATE Keynesan Model of the trade balance TB & ncome.. Key assumpton: P fxed =>. Mundell-Flemng model Key addtonal assumpton: nternatonal captal flows KA respond to nterest rates. Questons: Effect of fscal expanson or other ΔA. Effect of monetary expanson.

2 Recall the Keynesan model of the trade balance TB s a functon of the exchange rate & ncome: TB = X E - m. We now embody E effects (whether va exports or mports) n X; and we assume the Marshall-Lerner condton holds: dx de > 0.

3 Determnaton of ncome Trade Balance: TB = X(E) m. Aggregate output = domestc Aggregate Demand + net foregn demand: = A(, ) + TB(E, ), where da d More specfcally, let A(, ) = Ā - b() + c, where the functon -b( ) captures the negatve effect of the nterest rate on nvestment spendng, consumer durables, etc. Combnng equatons, Now solve to get the IS curve: = <0 and da d > 0. = A(, ) + TB(E, ) = Ā - b() + c + X E - m. Ā b() + X E s+m where s 1 c s the margnal propensty to save.

4 IS curve: An nverse relatonshp between and consstent wth supply = demand n the goods market. IS: = A b + X s+m IS IS' ΔA /(s + m) An ncrease n spendng, Ā, e.g., a fscal expanson, shfts IS to the rght by the multpler 1/(s+m).

5 The LM curve: Money supply = money demand. M1 P = L(, ) where dl d < 0, dl d > 0. LM Do central banks actually set the money supply? Supposedly n the 1980s heyday of monetarsm they set M1. A monetary expanson (M1 ) shfts the LM curve to the rght. Also the monetary base made a comeback after 2008: Quanttatve Easng. LM

6 The Mundell-Flemng equatons wth a fxed exchange rate IS: = A b + X s+m LM: M1 P = L(, ) IS LM Prof.J.Frankel

7 Monetary expanson n the Mundell-Flemng model: M1 IS: = A b + X s+m LM: M1 P = L(, ) IS LM LM' Or thnk of the central bank settng drectly. Prof.J.Frankel

8 Spendng expanson n the Mundell-Flemng model: A IS: = A b + X s+m LM: M1 P = L(, ) IS IS' Taylor rule LM Or the central bank may follow a Taylor Rule: settng systematcally n response to & nflaton. Prof.J.Frankel

9 The Mundell-Flemng model ntroduces captal flows IS BP=0 LM BP TB + KA TB = X m New addton: captal flows respond to nterest rate dfferental KA = KA + κ ( ) where κ d(ka), captal moblty. d( ) BP=0: X m + KA + κ = 0 We want to graph BP = 0. Solve for nterest dfferental: (-*) = 1 κ [( KA X] + (m κ ). Prof.J.Frankel

10 Prof.J.Frankel BP=0: (-*) = 1 [( KA X M ] + κ (m). κ The slope s (m/κ). κ = 0 κ > 0 κ >> 0 BP=0 Surplus BP=0 BP=0 Defct Captal moblty gves some slope to the BP=0 lne:. A rse n ncome and the trade defct s consstent wth BP=0 f hgher nterest rates attract a bg enough captal nflow.

11 Applcaton: Why dd many developng countres fnd themselves wth BoP surpluses durng & ? Strong economc performance (especally Asa) -- IS shfts rght. Easy monetary polcy n US and other major ndustralzed countres (low *) -- BP shfts down. Boom n mneral & agrcultural commodtes (esp. Afrca & Latn Amerca) -- BP shfts rght.

12 Causes of BoP Surpluses n Developng Countres , & I. Pull Factors (nternal causes) 1. Monetary stablzaton => LM shfts up 2. Removal of captal controls => κ rses 3. Spendng boom => IS shfts out/up II. Push Factors (external causes) 1. Low nterest rates n rch countres => * down => 2. Boom n export markets => } BP shfts out/ down